Dollar's Strength A Surprise

By JONATHAN FUERBRINGER

Published: August 7, 1989

Although it has fallen from its highs in June, the dollar is still showing surprising strength in what has been one of the most volatile periods of foreign-exchange trading in recent years, traders and economists say.

This resilience, even when the economy is slowing and interest rates are being nudged downward by the Federal Reserve, has led many forecasters to revise their outlook for the year. In contrast to their forecasts in December and even in May, they now predict that the dollar will rise, not fall, for the year.

But traders and economists do not expect the recent volatility in the market to disappear, which means there will still be sudden swings in the dollar, as on Friday, when it jumped more then three pfennigs against the West German mark and more than two Japanese yen. In that single day, the dollar regained what it had lost in the previous two weeks and ended just around the ceilings of 1.90 marks and 140 yen set for the dollar by the Group of Seven: Britain, Canada, France, Italy, Japan, West Germany and the United States. Economic Implications

For the economy, the stronger dollar means that American exports will be a bit more difficult to sell abroad than expected, which could further slow an economy that is already showing signs of weakness. But the higher dollar could help slow inflation by making imports from abroad a little cheaper than anticipated.

For currency traders, the volatility raises the daily stakes, creating a fast-moving environment in which sudden dips and rallies create opportunities to make - or lose - millions of dollars.

John Lipsky, the director of international bond market research for Salomon Brothers in London, had forecast in December that the dollar, which at the end of the year was at 124.95 yen and 1.77 marks, would fall about 10 percent against the yen and about 7 percent against the mark. He now expects the dollar to be around 130 yen and 1.80 marks at the end of the year.

He said his new dollar forecast reflected the switch in sentiment about the slowing economy. Earlier this year, the expectation had been that the slowdown could turn to a recession - a feeling that was temporarily revived several weeks ago and was responsible for the recent fall of the dollar that was halted on Friday. Sentiment for a 'Soft Landing'

But now the sentiment is that the economy is heading for a ''soft landing,'' with the economy slowing significantly and inflation subsiding, but without a recession.

This outlook is good for the dollar for two reasons. A soft landing is not as disruptive as a recession, so the foreign investments that support the dollar are more likely to continue.

Also, a soft landing would not force the Federal Reserve to push interest rates sharply lower to stimulate growth. Falling interest rates can put downward pressure on the dollar because they make investments in dollar-denominated securities less attractive to foreigners, prompting the selling of dollars. In addition, the optimism sparked by the expectation of a soft landing can even offset some of the pressure on the dollar from lower interest rates.

''What argues against any sustained downtrend,'' Mr. Lipsky said, ''is the expectation that the Federal Reserve will continue to follow a cautious path.'' More Bullish Forecast

Geoffrey E. Dennis, chief international economist for James Capel Inc. in New York, is a little more bullish than Mr. Lipsky, and his forecast has turned around even more.

He had expected the dollar to fall to around 112 yen and 1.61 marks. But now he expects it to fall a little from the current levels of about 1.90 marks and 140 yen and then rally back to that level at the end of the year, because the Fed will by then stop pushing interest rates down.

He also thinks the soft-landing theory has changed the outlook. In addition, he said, the dollar has been helped by some improvement in the United States trade deficit and, more important, the fact that the monthly trade reports have not had much effect on the market this year.

Unlike some other forecasters and traders, Mr. Dennis does not think the dollar will move much higher or break through the barriers of 2 marks and 150 yen that it swept past in June. If there is such a threat, he said, he expects the Federal Reserve and other central banks in the Group of Seven to intervene to keep the dollar down. Fickle Currency Market

Traders say the volatility will continue because of the fickle nature of the foreign-exchange market and the fact that it is moved by expectations of traders as much as by concrete economic statistics or interest-rate policy. And when the market does move sharply on expectations, it often overdoes it, which automatically sets up a rebound in the opposite direction.

''The fluctuations of the foreign-exchange market are often detached from the fundamentals,'' said Peter Rona, chief executive of IBJ Schroder Bank and Trust Company. ''The reasons are in the heads of the people, their expectations.''

In addition, economic reports of recent months have not given a clear sign of the economy's direction. The fact that the dollar burst though the Group of Seven's ceilings in June, without the central banks putting up much of a fight, also left the direction of policy unclear.

''There is a lot of confusion around,'' said John W. Baker, chief dealer at Bank Julius Baer & Company in New York. Sudden Shifts in the Outlook

These factors have led to sudden shifts in the outlook for the United States economy, inflation and the policy of the Federal Reserve. And this has made the market volatile.

There was such a sudden shift on Friday, when the dollar wiped out two weeks of decline and ended at 1.9070 marks and 139.90 yen, just at the ceilings set by the Group of Seven.

The rally was prompted by the employment report for July, which indicated that the economy was not declining as fast as had been anticipated on the basis of earlier reports. Based on the earlier data, many traders had expected the Fed to move faster to push interest rates lower to head off a recession, so they had sold dollars in anticipation. This selling had driven the dollar as low as 1.844 marks and 135.53 yen last week.

''The market exaggerated the move on the downside,'' Mark J. Rosaco, a vice president at Citibank, said after Friday's rally. ''The market was trading on a Fed funds rate of 7 1/2 percent,'' he said. The Fed funds rate, which is charged on overnight loans between banks, is closely controlled by the Federal Reserve and signals whether the central bank wants interest rates higher or lower. It is now at about 8 7/8 percent. ''With the employment number, we had to give it all back,'' Mr. Rosaco said. But he added, Friday's rebound was also overdone, setting up another, but not as sharp, move downward.